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Posted by: donmihaihai | November 16, 2008

Last quarter profits declined… Slumped! Plunged!! — part 1

United Food, one of the listed entities from China F&B cluster, went into red for the last quarter. While it can be say that Ufood being unlucky in the last quarter as the price of Soya bean collapsed and pulled Ufood profitability down there are no questions that UFood has been badly managed for a long time. Of course we can question the need to hold 3 to 4 months of Soya bean inventory and why import as they are widely available in their own country.

Reading Ufood performance review seem to lead us that the whole China F&B is in crisis in term of profitability as they blame EVERYTHING from government intervention, weak consumer confidence of China products, supply factors and even high level of competition in Chondroitin Sulphate which lead to the shut down of their Chondroitin Sulphate production. What they said are most probably true but Ufood forget to blame themselves, how poorly they manage their businesses and surprisingly it took so long before the management and board of directors are reviewing all their business units.

Why I said Ufood is so poorly managed? Just look at other locally listed China F&B companies will tell a better story, even the China Dairy which is in the Dairy product did better than Ufood in the last quarter not in profitability part but in revenues as revenues manage to increase. Looking at Ufood results, the impression is that consumer stopped consumption in 2008 which is impossible.

I am sorry to say to all Ufood shareholders that the chance of turnaround by current management is skyhigh as it is their own doing and not due to a single or few decisions. Even though Ufood B/S is super strong, it had destroyed shareholder value and will continue to do so. With the share price at $0.045 which is a discount of 80 to 90% of NBV or NCAV, I won’t want to bet on this management or take advantage of its discount to NBV or NCAV because time is against me. I think there are only 2 best ways to get a good return from this stock. 1st is change the owner-management and 2nd is to liquid Ufood and get back those cash and working capital, sell land rights and get some cash from their other hard assets. 2nd suggestion is to stop Ufood from continuing their activities of destroying value and the only way to do it is I guess by lobbying the Independent directors.

Since People Food is on their recovery from pig disease, its profit increased rather than decreased in the last quarter but it is not the same for it’s 36.75% associate Pine Agritech where Net profit for last quarter slumped 44% yoy. Ok this is old news as it has been going on for >1 years as Pine Agritech push into SOS product failed badly and the fortunes of Pine Agritech and Pfood swap places. If Pine Agritech push into retail has a better success, then it is another story but no it didn’t happen.

Despite all the bad news and slumping profit, Pine Agritech is actually performing pretty ok as it ROE for the 9mths were almost 13.5% as I exclude the interest expenses from convertible bonds. There are another 3 mths to go so Pine Agritech is likely to achieve an ROE of > 15%. This is I think very good for a company selling intermediate products with no pricing power for majority of their revenues. What more by taking away the convertible bonds, which look unlikely to be convert in the future, Pine Agritech B/S is very strong and with Pfood as their majority shareholder cum customer, Pine Agritech future in the soybean intermediate products is certain there, strong and perhaps big even though the future profitability of SPI is unlikely to return to their past but it is unlikely to get too bad too.

That reasonable return from SPI will fuel Pine Agritech venture into retail segment with their products like SOS and Tineng. It is not going to be easy but it is worthwhile to do it as that is where the margins lay. Pine had learnt a lesson with SOS and with the backing of Pfood on selling to consumer,(I keep wondering why the 1st SOS push failed so miserable from projection, a big mistake must be committed at that time) there is hope on the additional boast.

Owning Pine Agritech through Pfood is a good way as if Pine Agritech fail in their retail trying, it will still likely to be a strong player in the intermediate product of Soybean with a reliable customer. If the venture is a success, owning Pfood = owning two successful F&B companies in China. The still profitability Pine Agritech is trading at $0.10 which is about 30% discounted from NBV and 6 – 7X 2008 earnings.

China Dairy is in bad shape as NP was in the red in the last quarter. Of course the melamine in milk saga is a big hit to China Dairy bottom line not just on stock return to boast consumer goodwill but on addition costs that goes into operating expenses from reassuring consumer to addition manpower and working capital requirement. While Media talk about the greedy of the industry, I see another side of why it happened. The chances were, it was exactly due to declining profitability of all players in the supply chain that some players in the middle decided to add melamine to improve profit. It is the possibility that intense competition from all major milk players in China by cutting price and fighting for market shares. Past few years news on major milk players in this industry also shows that profitability were low despite being big.

It is the same story for China Dairy as profitability decrease despite revenues increased and that happened when China Dairy having big market share in Shaanxi. It was not a good business to be in and not going to be a good business to be in the future unless these price wars stop. While China Dairy is trading at 0.3 X BV at the price of $0.075, I am not sure if it is a good bet for the future if the continuous price wars cease not due to it smaller size but more due to the weak B/S caused by the past and it will get worse. But past actions from China Dairy pointed out that it is actually prudently managed so perhaps it is not time to write off China Dairy yet.

And don’t write off Dairy product producers from China in China as they will push those import products out with the pricing of local Dairy in the future.

Thank to Angel mooncake, China Angel swing back from red in 1H2008 but still posted a declined by 6% in NPAT in their 9 mths results. While China angel is trying to build up the other 2 business segments it is fair to say China Angel earns all its profit in this quarter with high profitability. This will be where I put my eyes on and hopefully the other 2 segments can drag among in at least reasonable returns.

But there are some negative in the last quarter results

1) High interest expenses. Due to season nature of its business, working capital will expand greatly and short term loans taken for this purpose should be a norm. Still, with cash from IPO and mooncake revenues increased by 21%, what made interest expenses increased by 594%?

2) Inventories written off increased by 3802% from 213K to 8,312K. What were those inventories? Due to melamine saga or mooncake or the pastry products? Perhaps this is the results of aggressive expansion.

3) 3,969K of equipment being written off. What are these? From retail outlet?

4) What kind of financial assets was China Angel buying?

5) Lastly, the management must weight the consequences of expanding too fast as distribution and administrative expenses jumped too fast. China Angel is another company where increased in A&P does not generate the same amount of sales proportionally. This shall be the area to watch and for the management to figure out.

With its share price at $0.05, China Angel is selling at about 2X earnings, 0.26X NBV, 0.4X NCAV. Is someone telling me that China Angel is going out of business soon? I will also bet that China Angel will give a nice level of dividend going forward as long as their retail outlets won’t kill China Angel as current year Capex won’t happen often. Judging by history, a 30 to 40% payout is pretty comfortable for China Angel.

Another China company that does not see increase profit in proportional with increasing A&P is Celestial. While its NPAT increased yoy for last quarter, it was not achieved through operation wise but rather by recognising exchange movement for its convertible bonds. And for many investors who invested into Celestial because it has pricing power with increasing profit will somehow setback by the fact that Celestial is just like other, facing the same problem, especially with the surging of soybean price. The only thing is it does not appear in the presentation of P&L due to numerous reasons I had write before.

Those who come in for dividends are going to be disappointed as well because this is not the 1st time management stop paying dividend as they think that they need those cash for expansion. So there may be a 3rd or 4th times in the future too.

Overall, with strong B/S and superb profitability, the market is giving a low price of $0.375 that put valued Celestial at 2.6X PE and 0.5X NBV. Is the price rational or perhaps the market is thinking the following issues will kill Celestial.

1) With increasing industry products, which include biodiesel assuming that Celestial push through after the trail run, Celestial will become more like Pine Agritech as more % of their profit will come from businesses with lower level of profitability. That haven’t include additional requirement of cash being suck into working capital.

2) The failure to increase retail products volume. While I have not calculate the increment, after taking away the increase in products price, volume increase yoy for retail products will likely be in the low single digit. Looking at utilitisation rate also give the same story.

I view it as a major concern because the pricing of local products usually ride the curve in purchasing power of the Chinese consumers. Which mean unless the company mis-managed like Ufood, revenues will increase pretty fast even if profitability level drop. So what is happening here? I don’t know but I make 2 guesses where 1st is the increase in selling price push consumer away which also helped by the Melamine saga. 2nd is distribution or selling points not managed properly as the number of selling point increased by about 50% from IPO till 2007.